Two big retailers eye store formats, expansion

Columbus, Ohio —based retail research firm TNS Retail Forward held its annual home improvement industry conference on Aug. 30, outlining the predictions for the next five years at the nation’s two largest home improvement retailers.

Both retailers face challenges in the coming years, but those challenges differ, analysts said. While Home Depot must deal with aging stores and fewer expansion opportunities, Lowe’s will face new challenges in Canada.

Economist and senior consultant Steve Spiwak said Home Depot faced impending market saturation and predicted the largest home improvement retailer would follow through on plans to diversify its store formats to continue expansion.

“Home Depot has its work cut out for it,” Spiwak said. On top of a weak housing market and major competitive pressures from Lowe’s, “it’s facing market saturation and an aging store base.”

For that reason, rather than continue strictly in the 100,000-square-foot and larger big-box format, the company could be considering smaller “25,000- to 50,000-” square-foot stores, “about the size of a neighborhood hardware store.”

Spiwak pointed to the company’s purchase of Yardbirds, which became Home Depot’s small-format offering in the San Francisco area. “Those basically were a way to get into the lucrative San Francisco bay area,” he said, but added the Yardbirds format could serve as a good “testing ground” for other areas of the country.

Yardbirds was a 10-unit chain of hardware stores purchased by Home Depot in 2006. The Atlanta retailer closed two locations and converted three others into Home Depot formats. In May, Home Depot converted two other former Yardbirds stores in Concord, Calif., and Petaluma, Calif., into a hybrid format under twin retail banners. The 40,000-square-foot units feature lower ceilings and fixtures, a racetrack layout and a large design center in the middle of the store. Neither location has lumber or building materials.

In addition to those stores, further test stores will be located in Alamo, San Pablo and San Rafael, Calif. The San Pablo store, the only Yardbirds to carry building materials, is expected to have a drive-though lumberyard.

Ace Hardware has, with smaller format stores, been able to “intercept a lot of customers and prevent them from going to the larger home centers, for home spruce up projects. It’s quicker, it’s faster,” he said. “The hardware co-ops are sort of banking on this approach of being convenient and offering a high level of service to their customers.”

Although Lowe’s does not face the same market saturation problems as Home Depot, nor the same issues with aging stores, it has expressed interest in further exploring smaller format stores in coming years, said Nick McCoy, senior consultant with Retail Forward.

Lowe’s is looking at “smaller markets and in-fill markets with smaller stores—80,000-square-foot stores that have done fairly well,” McCoy said, adding, “anything less than 80,000 square feet will be too small. Don’t look for Lowe’s to be opening small hardware-type stores any time soon.”

In dealing with tough market conditions, both analysts warned of slower growth for the two retailers in the next five years. The new market conditions favor those retailers who are better at catering to a more specialized market.

“Homeowners are now shifting to smaller, focused projects,” McCoy said. “Long story short is we’re probably not going to find a bottom this year [in the housing market]. There’s far fewer home equity cashouts happening these days. [Market conditions are] favoring small category specialists rather than the massive warehouse retailers.”

For Home Depot, Spiwak said Retail Forward is expecting to see “modest growth.” Home Depot lost some market share in the last year, and Spiwak says he predicts they will lose another 1 percent of share while growth slows.

“[Home Depot is] not going to be able to open up as many stores as it has in the past, and it’s going to be restrained by that market saturation,” he said.

One way of dealing with the housing slump, he said, is by focusing on “non-traditional events,” such as football tailgating and back-to-school sales.

“We expect, of course, that industry growth is slowing,” overall, McCoy said. “We expect it to be cut [roughly] in half over the next five years,” from 8.5 percent to 4.5 percent.

Lowe’s has helped its position, McCoy noted, by revamping its distribution network. The company recently reached its goal of having 75 percent of its products moving through its distribution system, which “vastly increased their flexibility for distribution management.”

Some rumors had swirled that Lowe’s could view RONA as a potential takeover target to further the company’s expansion. A report from Desjardins Securities put the probability of a takeover at 40 percent, “given Lowe’s need for physical locations.”

However, McCoy said he doubted a takeover would happen, and Lowe’s would instead concentrate on “organic growth.”

“There’s been a lot of speculation that Lowe’s might acquire RONA. I really don’t think that’s very likely,” he said. He noted that although Lowe’s did take a major market share step by acquiring Eagle Hardware & Garden in the late 1990s, he doesn’t believe RONA fits a mold that Lowe’s wants.

“[RONA] is just so vastly different form Lowe’s,” McCoy said. “I just don’t think that’s a logical alternative.”